Intermediate accounting IFRS 3rd ch07

 Allowance for Sales Returns and Allowances is a contra asset account to Accounts Receivable..  Two methods to account for uncollectible accounts: 1 Direct write-off method 2 Allowanc

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1. Indicate how to report cash and related items

2. Define receivables and explain accounting issues

related to their recognition

3. Explain accounting issues related to valuation of

accounts receivable.

4. Explain accounting issues related to recognition and

valuation of notes receivable

5. Explain additional accounting issues related to

accounts and notes receivables.

After studying this chapter, you should be able to:

LEARNING OBJECTIVES

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Intermediate Accounting IFRS 3rd Edition

Kieso ● Weygandt ● Warfield

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Cash

 Most liquid asset.

 Standard medium of exchange

 Basis for measuring and accounting for all other items.

 Current asset.

cashier’s checks, personal checks, bank drafts and savings accounts

LO 1

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Cash Equivalents

Short-term, highly liquid investments that are both

a) readily convertible to cash, and

b) so near their maturity that they present insignificant risk of changes in value

Examples: Government bonds, commercial paper, and money market funds

Reporting Cash

LO 1

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Companies segregate restricted cash from “regular” cash

Examples, restricted for:

(1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances

Restricted Cash

ILLUSTRATION 7.2

Disclosure of Restricted Cash

LO 1

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Bank Overdrafts

Company writes a check for more than the amount in its cash account

 Generally reported as a current liability.

part of a company’s cash management (such as the common practice of establishing o setting ffarrangements against other accounts at the same bank)

LO 1

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Written promises to pay a certain sum of money

on a specified future date

Receivables - Claims held against customers and others for money, goods, or services

Oral promises of the purchaser to pay for goods

and services sold

Receivable

Notes Receivable

LO 2

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Non-Trade Receivables

1. Advances to officers and employees.

2. Advances to subsidiaries.

3. Deposits paid to cover potential damages or losses.

4. Deposits paid as a guarantee of performance or payment.

5. Dividends and interest receivable.

6. Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for

tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods;

customers for returnable items (crates, containers, etc.).

LO 2

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ILLUSTRATION 7.3

Receivables Statement of Financial Position Sheet Presentations

LO 2

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 Accounts receivable generally arise as part of a revenue arrangement.

 The revenue recognition principle indicates that a company should recognize revenue

when it satisfies its performance obligation by transferring the good or service to the customer

LO 2

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For example, if Lululemon Athletica, Inc (CAN) sells a yoga outfit to Jennifer Burian for $100 on

account, the yoga outfit is transferred when Jennifer obtains control of this outfit When this change in

control occurs, Lululemon should recognize an account receivable and sales revenue Lululemon

makes the following entry:

Accounts Receivable 100

Sales Revenue 100

LO 2

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Some key indicators that Lululemon has transferred and that Jennifer has obtained control of the yoga

outfit

1. Lululemon has the right to payment from the customer

2. Lululemon has passed legal title to the customer

3. Lululemon has transferred physical possession of the goods

4. Lululemon no longer has significant risks and rewards of ownership of the goods

5. Jennifer has accepted the asset

LO 2

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The transaction price is the amount of consideration that a company expects to receive from a

customer in exchange for transferring goods or services

Measurement of the Transaction Price

In some cases, the price of a good or service is dependent on future events These future events often

include such items as discounts, returns and allowances, rebates, and performance bonuses

Variable Consideration

LO 2

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Use to:

 Avoid frequent changes in catalogs.

 Alter prices for different quantities purchased.

 Hide the true invoice price from competitors.

10 % Discount for new Retail Store Customers

Trade Discounts

LO 2

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 Offered to induce prompt payment.

 Terms such as 2/10, n/30, 2/10, E.O.M., or

net 30, E.O.M

 Gross Method vs Net Method.

Cash Discounts (Sales Discounts)

Payment terms are 2/10, n/30

LO 2

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ILLUSTRATION 7.5

Entries under Gross and Net Methods

LO 2

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 Sales Returns and Allowances is a contra revenue account to Sales Revenue

 Allowance for Sales Returns and Allowances is a contra asset account to Accounts Receivable

 The use of both Sales Returns and Allowances, and Allowance for Sales Return and Allowances

accounts is helpful to identify potential problems associated with inferior merchandise, inefficiencies in filling orders, or delivery or shipment mistakes

Sales Returns and Allowances

LO 2

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Illustration: Assume that Max Glass sells hurricane glass to Oliver Builders As part of the sales agreement, Max includes a provision that if Oliver is dissatisfied with the product, Max will grant an allowance on the sales price or

agree to take the product back

On January 4, 2019, Max sells $5,000 of hurricane glass to Oliver on account Max records the sale on account as

follows

Accounts Receivable 5,000

Sales Revenue 5,000

LO 2

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Illustration: Assume that Max Glass sells hurricane glass to Oliver Builders As part of the sales agreement, Max includes a provision that if Oliver is dissatisfied with the product, Max will grant an allowance on the sales price or

agree to take the product back

On January 16, 2019, Max grants an allowance of $300 to Oliver because some of the hurricane glass is defective

The entry to record this transaction is as follows

Sales Returns and Allowances 300

Accounts Receivable 300

LO 2

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On January 31, 2019, before preparing financial statements, Max estimates that an additional $100 in sales

returns and allowances will result from the sale to Oliver on January 4, 2019 An adjusting entry to record this

additional allowance is as follows

Sales Returns and Allowances 100

Allowance for Sales Returns and Allowances 100

LO 2

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 Theoretically, any revenue after the period of sale is interest revenue

 Companies ignore interest revenue related to accounts receivable because the amount of the discount

is not usually material in relation to the net income for the period

 The profession specifically excludes from present value considerations “receivables arising from

transactions with customers in the normal course of business which are due in customary trade terms not exceeding approximately one year.”

Time Value of Money

LO 2

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Alternate Presentation

LO 2

Adjustment of $15 for estimated bad debts?

Bad Debt Expense 15

Accounts Receivable

LO 2

Adjustment of $15 for estimated bad debts?

Bad Debt Expense 15

15 Est

Accounts Receivable

LO 2

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Allowance for Doubtful Accounts

Write-off of uncollectible accounts for $10?

Allowance for Doubtful accounts 10

Accounts Receivable

LO 2

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Allowance for Doubtful Accounts

Write-off of uncollectible accounts for $10?

Allowance for Doubtful accounts 10

W/O 10

10 W/O Accounts Receivable

LO 2

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 Record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense).

 Normal and necessary risk of doing business on credit.

 Two methods to account for uncollectible accounts:

1) Direct write-off method 2) Allowance method

Uncollectible Accounts Receivable

LO 3

Methods of Accounting for Uncollectible Accounts

Direct Write-Off Method

Theoretically deficient:

 Fails to record expenses as incurred.

 Receivable not stated at cash realizable value.

 Not appropriate when amount uncollectible is

material

LO 3

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Direct Write-Off Method for Uncollectible Accounts

When a company determines a particular account to be uncollectible, it charges the loss to Bad Debt Expense Assume, for example, that on December 10 Cruz Ltd writes o as uncollectible Yusado’s NT$8,000,000 balance ffThe entry is:

Bad Debt Expense 8,000,000

Accounts Receivable (Yusado) 8,000,000

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Allowance Method for Uncollectible Accounts

 Involves estimating uncollectible accounts at the end of each period

 Ensures that companies state receivables on the statement of financial position at their cash

realizable value

 Companies estimate uncollectible accounts and cash realizable value using information about

past and current events as well as forecasts of future collectibility

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Recording Estimated Uncollectibles

Illustration: Assume that Brown Furniture in 2019, its first year of operations, has credit sales of

£1,800,000 Of this amount, £150,000 remains uncollected at December 31 The credit manager estimates

that £10,000 of these sales will be uncollectible The adjusting entry to record the estimated uncollectibles

(assuming a zero balance in the allowance account) is:

Bad Debt Expense 10,000

Allowance for Doubtful Accounts 10,000

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ILLUSTRATION 7.5

Presentation of Allowance for Doubtful Accounts

The amount of £140,000 represents the cash realizable value of the accounts receivable at the statement date

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Recording the Write-Off of an Uncollectible Account

 When companies have exhausted all means of collecting a past-due account and collection

appears impossible, the company should write off the account

 In the credit card industry, for example, it is standard practice to write off accounts that are 210

days past due

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Illustration: The financial vice president of Brown Furniture authorizes a write-off of the £1,000 balance owed by

Randall plc on March 1 The entry to record the write-off is:

Allowance for Doubtful Accounts 1,000

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Estimating the Allowance

Percentage-of-Receivables Approach

 Reports estimate of receivables at cash realizable value.

Companies may apply this method using

 one composite rate, or

 an aging schedule using different rates.

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Bad Debt Expense 26,610

Allowance for Doubtful Accounts 26,610

What entry would Wilson

make assuming that the

allowance account had a

zero balance?

ILLUSTRATION 7.6

Accounts Receivable Aging Schedule

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Bad Debt Expense (€26,610 – €800) 25,810

Allowance for Doubtful Accounts 25,810

What entry would Wilson

make assuming the

allowance account had a

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Instructions: Prepare the journal entry to record Bad Debt Expense assuming Duncan Company estimates

bad debts at (a) 5% of accounts receivable and (b) 5% of accounts receivable but Allowance for Doubtful

Accounts had a $1,500 debit balance

Illustration: Duncan SA reports the following financial information before adjustments

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Bad Debt Expense 3,000

Allowance for Doubtful Accounts 3,000

€100,000 x 5% = €5,000 - €2,000 = €3,000

LO 3

Instructions: Prepare the journal entry to record Bad Debt Expense assuming Duncan Company estimates

bad debts at (a) 5% of accounts receivable

Illustration: Duncan SA reports the following financial information before adjustments

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Bad Debt Expense 6,500

Allowance for Doubtful Accounts 6,500

€100,000 x 5% = €5,000 + €1,500 = €6,500

LO 3

Instructions: Prepare the journal entry to record Bad Debt Expense assuming Duncan Company estimates bad

debts at (b) 5% of accounts receivable but the Allowance had a $1,500 debit balance

Illustration: Duncan SA reports the following financial information before adjustments

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 Written promise to pay a certain sum of money at a specific future date.

 A negotiable instrument.

 Maker signs in favor of a Payee.

 Interest-bearing (has a stated rate of interest) OR

 Zero-interest-bearing (interest included in face amount).

LO 4

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Generally originate from:

 Customers who need to extend payment period of an outstanding receivable

 High-risk or new customers.

 Loans to employees and subsidiaries.

 Sales of property, plant, and equipment.

 Lending transactions (the majority of notes).

LO 4

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Record at

Face Value , less allowance

Stated rate = Market rate

Stated rate > Market rate

Stated rate < Market rate

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Illustration: Bigelow SA lends Scandinavian Imports €10,000 in exchange for a €10,000, three-year note

bearing interest at 10 percent annually The market rate of interest for a note of similar risk is also 10 percent How does Bigelow record the receipt of the note?

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Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note The market rate

of interest for a note of similar risk is 9 percent How does Jeremiah record the receipt of the note?

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ILLUSTRATION 7.10

Discount Amortization Schedule—Effective-Interest Method

LO 4

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Illustration: Morgan Group makes a loan to Marie Co and receives in exchange a three-year, €10,000 note bearing interest at 10 percent annually The market rate of interest for a note of similar risk is 12 percent Prepare the journal entry to record the receipt of the note?

LO 4

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ILLUSTRATION 7.13

Discount Amortization Schedule—Effective-Interest Method

LO 4

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Notes Received for Property, Goods, or Services

In a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless:

1. No interest rate is stated, or

2. Stated interest rate is unreasonable, or

3. Face amount of the note is materially different from the

 current cash sales price or

 from the current market value of the debt instrument.

LO 4

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Illustration: Oasis Development Co sold a corner lot to Rusty Pelican as a restaurant site Oasis accepted in

exchange a five-year note having a maturity value of $35,247 and no stated interest rate The land originally cost Oasis

$14,000 At the date of sale the land had a fair market value of $20,000 Oasis uses the fair market value of the land,

$20,000, as the present value of the note Oasis therefore records the sale as:

Notes Receivable 20,000

Gain on Sale of Land ($20,000 - $14,000) 6,000

LO 4

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 Companies record and report short-term notes receivable at their cash realizable value.

 Computations and estimations involved in valuing short-term notes receivable and in recording

bad debt expense and the related allowance exactly parallel that for trade accounts receivable.

LO 4

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1. When the receivable no longer has any value; that is, the contractual rights to the cash flows of

the receivable no longer exist

2. When a company transfers (e.g., sells) a receivable to another company, thereby transferring

the risks and rewards of ownership to this other company

Derecognition of Receivables

Receivables

LO 5

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Various reasons for transfer of receivables to another party

 Accelerate the receipt of cash.

 Competition.

 Sell receivables because money is tight.

 Billing / collection are time-consuming and costly.

Transfer of receivables for cash happens in two ways:

1. Sales of receivables

2. Secured borrowing

Transfer of Receivables

LO 5

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Factors are finance companies or banks that buy receivables from businesses for a fee.

LO 5